L20: Vertical Relations

Question 1

vertical relations

Answer 1

product and distribution chains made up of different firms

manufacturers (upstream) rarely supply final consumers directly whilst retailers (downstream) make choices regarding the product

Question 2

what affects the choice to vertically integrate?

Answer 2

costs of VI
- as firm size and scope increase, harder to manage
- transaction costs to vertical mergers, compliance costs, etc.

benefits of VI
- non integrated partners are not always aligned with what is best for the vertical coalition
- integration is a way to get around this incentives misalignment

Question 3

holdup

Answer 3

firms in production chain make specific investments ex-ante

vertical integration solves this problem by internalising the externality
- externality that when you invest, you give benefits to others
- VI firm internalises full benefit form specific investment

Question 4

double marginalisation

Answer 4

happens when firms in vertical chain have market power
- upstream charges a markup on retailer and retailer charges markup on consumers
- firms do not fully internalise reduction in sales caused by each markup

double marginalisation because there are two steps with markups in both
- VI profit is higher than industry profit

Question 5

moral hazard

Answer 5

downstream firm may affect demand with other services/advertising
- manufacturer benefits from choosing these efforts
- similar to hold up but the other way around

Question 6

solutions to moral hazard

Answer 6

VI
- downstream internalises effects on upstream firm when integrated

contracts that specific and monitor minimum service levels
- avoids underinvestment by downstream firm

Question 7

contracts as a barrier to entry - Aghion and Bolton, 1987

Answer 7

can firms use contracts to prevent entry?

incumbents and buyers use contracts to extract surplus from potential entrants